don’t sweat the small stuff: a big picture perspective...
TRANSCRIPT
DON’T SWEAT THE SMALL STUFF: A BIG PICTURE PERSPECTIVE ON FINANCE
Aswath Damodaran
Email: [email protected]���Website: http://www.damodaran.com ���Blog: http://aswathdamodaran.blogspot.com Twitter: @AswathDamodaran Valuation app for iPad/iPhone: uValue on iTunes U
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Lesson 1: Every business decision is ultimately a financial one
¨ Every decision that a business makes has financial implications, and any decision which affects the finances of a business is a corporate finance decision.
¨ Defined broadly, everything that a business does fits under the rubric of corporate finance.
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So, watch out for these justifications
¨ The “Expert” Cop out: For many firms, the easiest way to explain the unexplainable is to pass the buck and get a consultant/expert to sign off on an action.
¨ Weapons of distraction: Managers/investors/analysts seem to find ways of over riding the numbers with buzz words. Here are some to watch out for: ¤ “Gut feeling” or “Intuition”: Older, more experienced managers
often claim to have a gut feeling about decisions. Psychological studies of gut feeling find that they are almost never based upon good data, are often completely wrong and get worse as managers get smarter/ more experienced.
¤ “Strategic”: The word “strategic” almost always goes to describe actions that cannot be justified based upon the numbers…
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The scariest page in your annual report
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Lesson 2: Have a destination before you leave: ���Have a dominant objective that is measurable…
¨ If you don’t have an objective, your decision making process has no rudder. Each manager will then create his or her own vision of where the business is going, and make decisions based on that vision.
¨ If you have multiple objectives, you will still have to make choices. If you are not clear about which objective should dominate, managers again will pick their own dominant objectives, leading to them working at cross purposes.
¨ If you have a fuzzy objective, you are giving no guidance on both how decisions should be made and no accountability for decisions, once made.
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What is L’Oreal’s objec8ve in business?
¨ The Beauty Mission? Giving everyone access to beauty by offering products in harmony with their needs, culture and expecta:ons in their infinite diversity.
¨ The Innova8on Mission? The explora:on of new scien:fic and technological territories….
¨ The Global Mission? Based on its interna:onal posi:ons and its power of innova:on, the Group’s ambi:on is to conquer a billion new consumers by 2020
¨ The Social Mission? As a company which seeks to be exemplary, and sets itself demanding standards in order to limit its footprint on the planet.
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Here is my choice…
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Lesson 3: In any business, you are juggling conflicting interests..
Inside stockholders Want to maximize value while
retaining control
Outside stockholders Want to maximize their returns
(stock price plus dividends).
Board of DirectorsWant to preserve personal connections with the managers and personal perks.
ManagersWant to maximize their compensation and increase personal marketability.
EmployeesWant to minimize job risk
and maximize wages/benefits.
Lenders Bankers/Bondholders
want to minimize credit risk and ensure that interest/principal
get paid.
Society Wants companies
to add to economic pie
without creating social costs.
CustomersWant the best possible product/service at the
lowest price
RegulatorsWant to ensure that you follow the rules
and do not create problems for them.
Government
Consultants Auditors
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With the board of directors as a good example of the conflict of interest…
¨ In theory, the board of directors should work to protect the best interests of stockholders, monitoring top management to ensure that they do their fiduciary duty.
¨ In practice, boards are not effective because: ¤ They are rubber stamps for CEOs: In many companies, the
directors who sit on the board are picked by the CEO and inside stockholders. While outside stockholders get to nominally vote on these directors, they are not given any real say in the process.
¤ Directors are ill equipped to play the role of monitors: Directors often lack the expertise to question top managers, lack the information to raise questions and the time to follow through.
¤ Directors are generally not large stockholders nor do they represent them: In most companies, directors own only token stakes in the company.
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The L’Oreal Board: Be the judge!
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Lesson 4: Understand the essence of risk
¨ Risk, in traditional terms, is viewed as a ‘negative’. Webster’s dictionary, for instance, defines risk as “exposing to danger or hazard”. The Chinese symbols for risk, reproduced below, give a much better description of risk:
危機 ¨ The first symbol is the symbol for “danger”, while
the second is the symbol for “opportunity”, making risk a mix of danger and opportunity. You cannot have one, without the other.
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Risk can come from many places…
Actions/Risk that affect only one firm
Actions/Risk that affect all investments
Firm-specific Market
Projects maydo better orworse thanexpected
Competitionmay be strongeror weaker thananticipated
Entire Sectormay be affectedby action
Exchange rateand Politicalrisk
Interest rate,Inflation & news about economy
Figure 3.5: A Break Down of Risk
Affects fewfirms
Affects manyfirms
Firm can reduce by
Investing in lots of projects
Acquiring competitors
Diversifying across sectors
Diversifying across countries
Cannot affect
Investors can mitigate by
Diversifying across domestic stocks Diversifying across asset classes
Diversifying globally
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And not all risk is made equal…
¨ If you are a sole owner of a business, you are exposed to all of the risks in a business. Thus, your hurdle rate should reflect those risks.
¨ If you are a publicly traded company, the game changes. As a manager, you have look at risk through the eyes of the marginal investor in your company. There are two criteria that go into being a marginal investor: ¤ You need to own enough stock to make a difference. In other words, you
have to be a large stockholder. ¤ You have to trade that stock. Thus, a founder who owns a lot of stock but
does not trade is not the marginal investor. ¨ If that marginal investor is a mutual fund or institutional investor,
the only risk they see in an investment is the risk that it adds to a diversified portfolio. Consequently, the only risk you as a manager should build into your hurdle rate is the risk that cannot be diversified away.
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Know your marginal investor..
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Your risk is not a sta8s8cal number or a greek alphabet..
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But comes from your choices as a business..
Beta of Firm
Beta of Equity
Nature of product or service offered by company:Other things remaining equal, the more discretionary the product or service, the higher the beta.
Operating Leverage (Fixed Costs as percent of total costs):Other things remaining equal the greater the proportion of the costs that are fixed, the higher the beta of the company.
Financial Leverage:Other things remaining equal, the greater the proportion of capital that a firm raises from debt,the higher its equity beta will be
Implications1. Cyclical companies should have higher betas than non-cyclical companies.2. Luxury goods firms should have higher betas than basic goods.3. High priced goods/service firms should have higher betas than low prices goods/services firms.4. Growth firms should have higher betas.
Implications1. Firms with high infrastructure needs and rigid cost structures shoudl have higher betas than firms with flexible cost structures.2. Smaller firms should have higher betas than larger firms.3. Young firms should have
ImplciationsHighly levered firms should have highe betas than firms with less debt.
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Let’s do an intui8ve check on L’Oreal
¨ In your annual report, you break yourself down into six businesses: a. Consumer Products (growth = 5.8%) b. L’Oreal Luxe (growth = 6.8%) c. Professional Products d. Ac8ve Cosme8cs e. The Body Shop f. Galderma Do you see them all as equally risky businesses? If not, how would you rank them (from most to least risky)?
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Lesson 5: Know your “hurdle” rate
¨ Since financial resources are finite, there is a “hurdle rate” that projects have to cross before being deemed acceptable. A simple representation of the hurdle rate is as follows:
Hurdle rate = Riskless Rate + Risk Premium In what currency are you estimating your hurdle rate? How risky is the business that you are investing in?
Higher risk investments should have higher risk premiums than lower risk investments
How risky are the countries that you are investing in?You should demand a higher risk premium for
operating in riskier countries that safer countries
How are you financing this investment?The hurdle rate is a function of your mix of debt &
equity and how much it costs you to raise debt
Black #: Total ERP Red #: Country risk premium AVG: GDP weighted average
ERP
: Jan
201
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Angola 10.40% 5.40% Benin 13.25% 8.25% Botswana 6.28% 1.28% Burkina Faso 13.25% 8.25% Cameroon 13.25% 8.25% Cape Verde 13.25% 8.25% DR Congo 14.75% 9.75% Egypt 16.25% 11.25% Gabon 10.40% 5.40% Ghana 11.75% 6.75% Kenya 11.75% 6.75% Morocco 8.75% 3.75% Mozambique 11.75% 6.75% Namibia 8.30% 3.30% Nigeria 10.40% 5.40% Rep Congo 10.40% 5.40% Rwanda 13.25% 8.25% Senegal 11.75% 6.75% South Africa 7.40% 2.40% Tunisia 10.40% 5.40% Uganda 11.75% 6.75% Zambia 11.75% 6.75% Africa 10.04% 5.04%
Bangladesh 10.40% 5.40% Cambodia 13.25% 8.25% China 5.90% 0.90% Fiji 11.75% 6.75% Hong Kong 5.60% 0.60% India 8.30% 3.30% Indonesia 8.30% 3.30% Japan 5.90% 0.90% Korea 5.90% 0.90% Macao 5.90% 0.90% Malaysia 6.80% 1.80% Mauritius 7.40% 2.40% Mongolia 11.75% 6.75% Pakistan 16.25% 11.25% Papua New Guinea 11.75% 6.75% Philippines 8.30% 3.30% Singapore 5.00% 0.00% Sri Lanka 11.75% 6.75% Taiwan 5.90% 0.90% Thailand 7.40% 2.40% Vietnam 13.25% 8.25% Asia 6.51% 1.51%
Australia 5.00% 0.00% Cook Islands 11.75% 6.75% New Zealand 5.00% 0.00% Australia & New Zealand 5.00% 0.00%
Argentina 14.75% 9.75% Belize 18.50% 13.50% Bolivia 10.40% 5.40% Brazil 7.85% 2.85% Chile 5.90% 0.90% Colombia 8.30% 3.30% Costa Rica 8.30% 3.30% Ecuador 16.25% 11.25% El Salvador 10.40% 5.40% Guatemala 8.75% 3.75% Honduras 13.25% 8.25% Mexico 7.40% 2.40% Nicaragua 14.75% 9.75% Panama 7.85% 2.85% Paraguay 10.40% 5.40% Peru 7.85% 2.85% Suriname 10.40% 5.40% Uruguay 8.30% 3.30% Venezuela 16.25% 11.25% Latin America 8.62% 3.62%
Albania 11.75% 6.75% Armenia 9.50% 4.50% Azerbaijan 8.30% 3.30% Belarus 14.75% 9.75% Bosnia and Herzegovina 14.75% 9.75% Bulgaria 7.85% 2.85% Croatia 8.75% 3.75% Czech Republic 6.05% 1.05% Estonia 6.05% 1.05% Georgia 10.40% 5.40% Hungary 8.75% 3.75% Kazakhstan 7.85% 2.85% Latvia 7.85% 2.85% Lithuania 7.40% 2.40% Macedonia 10.40% 5.40% Moldova 14.75% 9.75% Montenegro 10.40% 5.40% Poland 6.28% 1.28% Romania 8.30% 3.30% Russia 7.40% 2.40% Serbia 11.75% 6.75% Slovakia 6.28% 1.28% Slovenia 8.75% 3.75% Ukraine 16.25% 11.25% E. Europe & Russia 7.96% 2.96%
Abu Dhabi 5.75% 0.75% Bahrain 7.85% 2.85% Israel 6.05% 1.05% Jordan 11.75% 6.75% Kuwait 5.75% 0.75% Lebanon 11.75% 6.75% Oman 6.05% 1.05% Qatar 5.75% 0.75% Saudi Arabia 5.90% 0.90% United Arab Emirates 5.75% 0.75% Middle East 6.14% 1.14%
Canada 5.00% 0.00% United States of America 5.00% 0.00% North America 5.00% 0.00%
Andorra 6.80% 1.80% Liechtenstein 5.00% 0.00% Austria 5.00% 0.00% Luxembourg 5.00% 0.00% Belgium 5.90% 0.90% Malta 6.80% 1.80% Cyprus 20.00% 15.00% Netherlands 5.00% 0.00% Denmark 5.00% 0.00% Norway 5.00% 0.00% Finland 5.00% 0.00% Portugal 10.40% 5.40% France 5.60% 0.60% Spain 8.30% 3.30% Germany 5.00% 0.00% Sweden 5.00% 0.00% Greece 20.00% 15.00% Switzerland 5.00% 0.00% Iceland 8.30% 3.30% Turkey 8.30% 3.30% Ireland 8.75% 3.75% United Kingdom 5.60% 0.60% Italy 7.85% 2.85% Western Europe 6.29% 1.29%
Aswath Damodaran
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One hurdle rate will generally not work across the company ¨ If you are a single business company, but you are a mul8na8onal, your
hurdle rate will vary, depending on where you are inves8ng. For instance, if we view L’Oreal as being just in the cosme8cs business, which has a beta of 0.97 (adjusted up to 0.99, reflec8ng L’Oreal’s debt), the cost of equity (even in US$ terms) will vary depending on where the investment is going to be made:
Region % of Loreal Revenues
Risk free Rate Regional ERP
Beta for cosme:cs Cost of equity
Africa 1.2 2.50% 10.04% 0.99 12.44% Asia-‐Pacific 20.6 2.50% 6.51% 0.99 8.94% Central and South America 8.9 2.50% 8.62% 0.99 11.04% Eastern Europe 7.9 2.50% 7.96% 0.99 10.38% Middle East 1.2 2.50% 6.14% 0.99 8.58% North America 25.1 2.50% 5.00% 0.99 7.45% Western Europe 35.1 2.50% 6.29% 0.99 8.73% L"Oreal 2.50% 6.40% 0.99 8.84%
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A Mul8-‐business Company: Disney & a Ques8on for L’Oreal
!!Cost!of!equity!
Cost!of!debt!
Marginal!tax!rate!
After6tax!cost!of!debt!
Debt!ratio!
Cost!of!capital!
Media!Networks! 9.07%! 3.75%! 36.10%! 2.40%! 9.12%! 8.46%!Parks!&!Resorts! 7.09%! 3.75%! 36.10%! 2.40%! 10.24%! 6.61%!Studio!Entertainment! 9.92%! 3.75%! 36.10%! 2.40%! 17.16%! 8.63%!Consumer!Products! 9.55%! 3.75%! 36.10%! 2.40%! 53.94%! 5.69%!Interactive! 11.65%! 3.75%! 36.10%! 2.40%! 29.11%! 8.96%!Disney!Operations! 8.52%! 3.75%! 36.10%! 2.40%! 11.58%! 7.81%!
Earlier, we looked at L’Oreal’s multiple business lines. Do you think that you should be giving them different costs of equity and capital and demanding higher returns in some than others?
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Lesson 6: Your investments need to earn returns that beat the hurdle rate…
¨ Your hurdle rate is both a cost of financing your business and an opportunity cost, i.e,, a return you can make elsewhere if you invest in a project of equivalent risk. If that is the case, you should only take investments that generate returns that earn more than the hurdle rate.
¨ To measure returns, though, here are three simple propositions to follow:
1. Look at the cash flows that you will make on the investment, rather than earnings. You cannot spend earnings.
2. Look at incremental cash flows that come out because of the investment. Be wary of allocated costs (that will be there whether you take the investment or not) and ignore sunk costs (costs that you have already incurred).
3. Time weight the cash flows, with cash flows occurring earlier being valued more than cash flows later.
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Here is a short cut that you can use to assess the quality of your existing investments…
ROC = EBIT ( 1- tax rate)
Book Value of Equity + Book value of debt - Cash
Adjust EBIT fora. Extraordinary or one-time expenses or incomeb. Operating leases and R&Dc. Cyclicality in earnings (Normalize)d. Acquisition Debris (Goodwill amortization etc.)
Use a marginal tax rateto be safe. A high ROC created by paying low effective taxes is not sustainable
Adjust book equity for1. Capitalized R&D2. Acquisition Debris (Goodwill)
Adjust book value of debt fora. Capitalized operating leases
Use end of prior year numbers or average over the yearbut be consistent in your application
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Your best businesses, your worst ones and where you stand as a company..
Business Revenues Opera:ng Income
Opera:ng Assets
Invested Capital Tax Rate
Opera:ng Margin ROIC
Cost of capital
Excess Return
Professional Products 2,984 € 610 € 3,014 € 4,028 € 26.41% 15.04% 11.15% 8.65% 2.50% Consumer Products 10,873 € 2,167 € 6,449 € 8,618 € 26.41% 14.67% 18.50% 8.65% 9.85% L'Oreal Lux 5,865 € 1,174 € 4,383 € 5,857 € 26.41% 14.73% 14.75% 8.65% 6.10% Ac8ve Cosme8cs 1,602 € 340 € 833 € 1,113 € 26.41% 15.62% 22.48% 8.65% 13.83% Cosme:cs 21,324 € 4,291 € 14,679 € 19,616 € 26.41% 14.81% 16.10% 8.65% 7.45% The Body Shop 836 € 72 € 1,197 € 1,600 € 26.41% 6.34% 3.31% 8.65% -‐5.34% Dermatology 826 € 117 € 1,159 € 1,549 € 26.41% 10.42% 5.56% 8.65% -‐3.09% Overall Company 22,977 € 3,875 € 17,634 € 23,565 € 26.41% 12.41% 12.10% 8.65% 3.45%
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Lesson 7: Acquisitions are just big investments and have to meet the same standards..
¨ An acquisition is just a large-scale project. All of the rules that apply to individual investments apply to acquisitions, as well. For an acquisition to create value, it has to ¤ Generate a higher return on capital, after allowing for synergy and
control factors, than the cost of capital. ¤ Put another way, an acquisition will create value only if the present
value of the cash flows on the acquired firm, inclusive of synergy and control benefits, exceeds the cost of the acquisitons
¨ A divestiture is the reverse of an acquisition, with a cash inflow now (from divesting the assets) followed by cash outflows (i.e., cash flows foregone on the divested asset) in the future. If the present value of the future cash outflows is less than the cash inflow today, the divestiture will increase value.
¨ A fair-price acquisition or divestiture is value neutral.
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And of all the ways to create growth, acquisitions rank worst…
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Lesson 8: You have only two ways of raising funding for a business…
Fixed ClaimTax DeductibleHigh Priority in Financial TroubleFixed MaturityNo Management Control
Residual ClaimNot Tax DeductibleLowest Priority in Financial TroubleInfinite Management Control
DebtBank DebtCommercial PaperCorporate Bonds
EquityOwner’s EquityVenture CapitalCommon StockWarrants
Hybrid SecuritiesConvertible DebtPreferred StockOption-linked Bonds
Figure 7.1: Debt versus Equity
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And here is the trade off….
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Lesson 9: There is a “right” mix of debt and equity for your business…
Cost of capital = Cost of Equity (Equity/ (Debt + Equity)) + Pre-tax cost of debt (1- tax rate) (Debt/ (Debt + Equity)
Tax benefit ishere
Bankruptcy costs are built into both the cost of equity the pre-taxcost of debt
As you borrow more, he equity in the firm will become more risky as financial leverage magnifies business risk. The cost of equity will increase
As you borrow more, your default risk as a firm will increase pushing up your cost of debt.
At some level of borrowing, your tax benefits may be put at risk, leading to a lower tax rate.
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Be wary of companies that are too aggressive… and too conservative… in their use of debt…
¨ If you use too little debt (you are too conservative), you are missing the tax benefits from using debt that would have lowered your cost of capital and increased your value as a business. ¤ Prime candidates: Mature companies that have large, stable cash flows, face high
tax rates and use little or no debt to capitalize themselves. ¤ Fixes: At the minimum, borrow more when funding new projects and pay more
dividends. More radically, borrow money and recapitalize. ¨ If you use too much debt, your tax benefits may be overwhelmed by the
cost of distress and default. Consequently, you have a higher cost of capital and lower value as a business, because you have chosen to borrow too much. ¤ Prime candidates: Companies in risky businesses that have other fixed commitments
to meet and low or volatile income, while borrowing large amounts. ¤ Fixes At the minimum, cut back or stop paying dividends and utilize retained
earnings to fund investments. More radically, raise new equity and retire debt.
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L’Oreal: Current versus Op8mal
Debt Ratio Beta Cost of Equity
Bond Rating
Interest rate on debt Tax Rate
Cost of Debt (after-tax) WACC
Enterprise Value
0% 0.9701 8.71% Aaa/AAA 2.90% 33.33% 1.93% 8.71% $62,158 3% 0.99 8.84% Aaa/AAA 2.90% 33.33% 1.93% 8,63% $62,954 10% 1.0420 9.17% Aaa/AAA 2.90% 33.33% 1.93% 8.45% $64,913 20% 1.1318 9.74% Aaa/AAA 2.90% 33.33% 1.93% 8.18% $67,925 30% 1.2473 10.48% A1/A+ 3.35% 33.33% 2.23% 8.01% $70,066 40% 1.4013 11.47% A3/A- 3.80% 33.33% 2.53% 7.89% $71,541 50% 1.6169 12.85% Caa/CCC 11.25% 33.33% 7.50% 10.17% $50,288 60% 1.9804 15.17% Caa/CCC 11.25% 30.58% 7.81% 10.76% $46,747 70% 2.6776 19.64% Ca2/CC 12.00% 24.57% 9.05% 12.23% $39,676 80% 4.0805 28.62% C2/C 13.00% 19.85% 10.42% 14.06% $33,387 90% 8.1610 54.73% C2/C 13.00% 17.64% 10.71% 15.11% $30,607
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Lesson 10: The “right” debt for your firm depends on your firm
¨ The objective in designing debt is to make the cash flows on debt match up as closely as possible with the cash flows that the firm makes on its assets.
¨ By doing so, we reduce our risk of default, increase debt capacity and increase firm value.
Firm Value
Value of Debt
Firm Value
Value of Debt
Unmatched Debt Matched Debt
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The perfect debt for you is….
¨ The perfect financing instrument will ¤ Have all of the tax advantages of debt ¤ While preserving the flexibility offered by equity
Duration Currency Effect of InflationUncertainty about Future
Growth PatternsCyclicality &Other Effects
Define DebtCharacteristics
Duration/Maturity
CurrencyMix
Fixed vs. Floating Rate* More floating rate - if CF move with inflation- with greater uncertainty on future
Straight versusConvertible- Convertible ifcash flows low now but highexp. growth
Special Featureson Debt- Options to make cash flows on debt match cash flows on assets
Start with the Cash Flowson Assets/Projects
Commodity BondsCatastrophe Notes
Design debt to have cash flows that match up to cash flows on the assets financed
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Lesson 11: Cash is not accumulated by accident, & cash does not belong to the company
FCFE = Potential Dividends = Cash left over after all operating expenses, taxes, reinvestment and debt payments have been made.
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Not all cash balances are created equal…
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Lesson 12: The value of your business is a function of these variables…
EBIT (1-t) = $4,795- Reinvestment = $1,199= FCFF = $3,596
Terminal Value10= 3,596/(..08-.025) = $65,389
Firm’s D/ERatio: 3.91%
Unlevered Beta for Sectors: 0.97
Equity Risk Premium6.40%
Beta 0.99
Riskfree Rate:Riskfree Rate=
2.50%
Op. Assets $49,219+ Cash: 2,607- Debt 1,905
+ Cross holds11,852=Equity $61,773
- Options 644Value/Share $100.81
WeightsE = 87.02% D =
2.97%
Cost of Debt(2.50%+0.80%)(1-.3333) = 2.20%
Stable Growthg = 2.5%; Beta = 1.00Cost of capital = 8.00%
Tax rate = 26.41% ROC= 10%;
Reinvestment Rate=g/ROC =2.5%/ 10%= 25%
Cost of Equity8.84%
+ X
L'Oreal: September 2014
On September 2, 2014L"Oreal Price = $104.90/share
$ Cashflows
Growth declines to 2.5% and cost of capital moves to stable period level.
Cost of capital = 8.84% (.8703) + 1.98% (.0297) = 8.65%
Africa 1.2 10.04%Asia.Pacific 20.6 6.51%Latin5America 8.9 8.62%Eastern5Europe 7.9 7.96%Middle5East 1.2 6.14%North5America 25.1 5.00%Western5Europe 35.1 6.29%L"Oreal( 6.40%
1 2 3 4 5 6 7 8 9 10EBIT(1-t) 3,240.98$ 3,403.03$ 3,573.18$ 3,751.84$ 3,939.43$ 4,116.71$ 4,281.38$ 4,431.22$ 4,564.16$ 4,678.26$ - Reinvestment 765.90$ 804.20$ 844.40$ 886.62$ 930.96$ 879.75$ 817.19$ 743.65$ 659.72$ 566.26$ FCFF 2,475.08$ 2,598.84$ 2,728.78$ 2,865.22$ 3,008.48$ 3,236.95$ 3,464.18$ 3,687.58$ 3,904.44$ 4,112.00$
L"Oreal IndustryRevenues 22,977$,,,,,Operating,income 3,875$,,,,,,,,Revenue,growth 2.29% 4.78%Pre?tax,operating,margin 18.25% 10.51%Sales,to,capital,ratio 1.12 2.57Return,on,invested,capital 14.74% 17.09%
Revenue Growth5%/ year for next 5
years, scaling down to 2.5% in year 10
Operating MarginStays at 18.25% Sales/
Capital ratio of 1.50
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And here is how you can change your value
Cashflows from existing assetsCashflows before debt payments, but after taxes and reinvestment to maintain exising assets
Expected Growth during high growth period
Growth from new investmentsGrowth created by making new investments; function of amount and quality of investments
Efficiency GrowthGrowth generated by using existing assets better
Length of the high growth periodSince value creating growth requires excess returns, this is a function of- Magnitude of competitive advantages- Sustainability of competitive advantages
Stable growth firm, with no or very limited excess returns
Cost of capital to apply to discounting cashflowsDetermined by- Operating risk of the company- Default risk of the company- Mix of debt and equity used in financing
How well do you manage your existing investments/assets?
Are you investing optimally forfuture growth? Is there scope for more
efficient utilization of exsting assets?
Are you building on your competitive advantages?
Are you using the right amount and kind of debt for your firm?